Question: I have $1 million saved for retirement, but I’m not sure how that translates to retirement income. Now that I’m ready to retire, how much can I withdraw each year from my nest egg? Should I follow the 4% rule?
Answer: For many people, saving for retirement revolves around having enough money stashed away in retirement accounts. But once you’re retired, it’s also important to have a plan for withdrawing that money. If you don’t plan, you could end up running out of money too soon. This is one of the most common concerns among retirees. Determining how much you can reasonably withdraw from your savings each year can go a long way toward protecting you from that risk.
So how do you do that?
The amount of money you can withdraw from your retirement savings each year depends on many factors, most of which will vary depending on the individual. This makes identifying a universal number that works for everyone a difficult (and not terribly useful) task.
Whether you have $1 million, $5 million or more saved for retirement, your unique circumstances and preferences will influence how much you can expect to withdraw each year.
Here’s a framework for thinking about how much you can pull from retirement savings each year.
[What Is the 25x Rule for Retirement Saving?]
Determine Your Retirement Withdrawal Rate
Start by thinking about the amount you withdraw each year in proportion to your total balance. We call this a withdrawal rate. For example, if you have $1 million in your retirement savings and you withdraw $100,000, that is a 10% withdrawal rate. Taking out $10,000 would give you a 1% withdrawal rate. While a 10% withdrawal rate would be too high for most and put you at risk of depleting your savings quickly, 1% is likely too low.
Fortunately, research on withdrawal rates gives retirement savers some basis for understanding how much they can take from their accounts in retirement. The most famous and frequently cited study introduced what is known as the 4% rule. This serves as a good starting point.
Get to Know the 4% Rule
The 4% rule suggests that if someone retired and withdrew 4% of their balance in the first year — and adjusted their withdrawal for inflation each year after — their money would have lasted for at least 30 years. If you have $1 million saved and follow the 4% rule, you’d withdraw $40,000 in the first year of retirement.
I don’t think of it as a rule but more of a guideline. This research has been applauded, criticized, modified and extended in other papers in the roughly 30 years since it was published. Rather than blindly following the rule or tossing it altogether because newer studies have suggested other approaches, I think we can still use the insights it contains as a useful guide for determining individual withdrawal rates.
Modifications to Determine Your Own Withdrawal Rate
Take a look at some of the major inputs that back up the 4% rule and think about how you may want to tailor each of these to fit your situation better.
Retirement Timespan
The study focused on a 30-year retirement because that was considered to be a reasonable time period, and it probably is for most people. But if you expect that you won’t live 30 years in retirement due to family history or personal health challenges, then you may not need your money to last that long. You may withdraw more. Of course, if you retire young and expect to live longer than 30 years in retirement, you may want to adjust in the other direction.
Your Investment Approach
The study also tested different investment allocations and concluded that allocations between 50% and 75% equity were optimal. Again, this is a reasonable allocation that will work for a lot of retirees. Most follow a 60/40 allocation, which is right in the middle. But if you are especially conservative, you may need to adjust your withdrawal rate downward. Equities tend to provide better long-term returns than bonds, and your portfolio may not be able to sustain a higher withdrawal rate if you hold too few stocks.
Withdrawal Adjustments
In the paper, the only way withdrawals were adjusted after the first year was for inflation. For example, assume again that you started with $1 million and withdrew $40,000 in the first year. If inflation was 5% that year, you’d withdraw $42,000 in the next year.
However, you may be able to get more from your savings by employing a variable withdrawal rate. With this approach, you might forego the inflation increase if your portfolio loses money in one year. You may also reduce your withdrawal if your current withdrawal rate exceeds a certain number, such as 6%.
There are several ways to do it, but the idea is that flexibility can go a long way toward making your money last. By having a flexible withdrawal plan you could start with a higher initial rate.
Consider Other Sources of Income
Determine how much risk you are comfortable with and can afford to take with your savings. If savings withdrawals are your only source of income, you need to be especially careful. A more conservative distribution strategy may be warranted.
However, if you have significant other income that isn’t tied to your savings balance, such as Social Security, pension, annuity or rental income, you may not need to be so concerned about your savings. This is what is called an income floor. If you have a substantial floor, you could be OK taking a little more now, even if it increases the odds that your savings will deplete sooner.
[Read: The Future of Social Security.]
I Have $1 Million in Retirement Savings. How Much Can I Withdraw in Retirement?
It’s all about balance. Each person is unique. You can use the 4% rule as a starting point, then make adjustments to create a withdrawal plan that more closely matches your own set of expectations and circumstances.
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Ask a Financial Pro: I Have $1 Million in Retirement Savings. How Much Can I Withdraw Each Year in Retirement? originally appeared on usnews.com
